Rating Action: Moody's downgrades Iceland VLNCo Limited to B3 from B2; outlook negativeGlobal Credit Research - 23 Aug 2022London, August 23, 2022 -- Moody's Investors Service ("Moody's") has today downgraded the corporate family rating (CFR) of Iceland VLNCo Limited (Iceland or the company) to B3 from B2 and the probability of default rating (PDR) to B3-PD from B2-PD. Concurrently, the rating agency has downgraded to B3 from B2 ratings of the outstanding backed senior secured notes issued by Iceland Bondco plc's (Bondco). The outlook on all ratings was changed to negative from stable.The rating action reflects Moody's expectations that Iceland's credit metrics will deteriorate more than factored in the previous rating over the next 12-18 months. Moody's views reflect an increasingly challenging economic environment, with already strong evidence of high inflation affecting consumer spending even for groceries, as well as rising input and energy costs, as only partly mitigated by ongoing initiatives to increase productivity.The rating action also reflects Moody's view that Iceland's leverage will increase over the next 12-18 months, its interest coverage is likely to remain around 1x and that its free cashflows, already limited, will turn negative, thus increasing the risk of refinancing execution of the notes due in March 2025.A full list of affected ratings can be found at the end of this press release.RATINGS RATIONALEThe B3 rating is supported by the company's niche position in the food market with a solid share of frozen food products as well as its ability to differentiate from other discounters through product innovation and the provision of home delivery and on-line services. Iceland has been growing share of the market for frozen food in recent years, a trend that has accelerated during the pandemic months. The company has also resolved question marks over its long-term ownership.Iceland's leverage has increased to 5.8x in fiscal 2022 (ended 25 March), from 5.0x at the end of fiscal 2021, more than previously factored in Moody's base case. Moody's-adjusted interest coverage, measured as adjusted EBIT to adjusted interest, has weakened further to 1.0x from 1.9x previously. Iceland generated Â£29 million of Moody's adjusted free cash flow in fiscal 2022, representing only 1.9% of Moody's adjusted gross debt compared to 6.5% in the prior fiscal year.Rising inflation is likely to erode the already thin operating margins of UK grocers this year as the sector remains very competitive and companies are cautious to raise prices in order to preserve market share. One of the main challenges for the industry, and for Iceland in particular, given its greater focus on energy-intensive frozen food, is represented by rising energy costs. Moody's expects that Iceland's electricity bill will more than double in fiscal 2023, ending March, compared to the prior year, thus reducing the company's EBITDA and causing leverage to increase more than previously anticipated. Partly mitigating rising costs of goods sold, energy costs and personnel expenses, Iceland continues to simplify processes in its stores and supply chain in order to reduce costs and preserve margins.Moody's base case currently anticipates leverage to rise and remain materially above 6.0x over the next 12-18 months, interest over to remain around 1x and free cash flow generation to turn negative.Refinancing risk is also increasing for many highly levered issuers. Bondco has Â£550 million backed senior secured notes due March 2025 carrying a coupon of 4.625%, currently trade well below par, which suggest that the company's cost of debt is likely to increase after a refinancing. The company's already weak credit metrics, and in particular its interest cover and free cash flows, would likely come under more pressure if the company is unable to refinance at similarly low rates.Iceland's ESG Credit Impact Score is high (CIS-4). This is due to the company's exposures to governance risks, including an aggressive financial strategy reflected in high leverage and a board of directors with that is effectively controlled by the owning family. As a specialty grocer, Iceland has moderate environmental and social risk exposures mainly owing to carbon transition and customer relations risks.RATIONALE FOR THE NEGATIVE OUTLOOKThe negative outlook reflects the risk that Iceland's profitability may remain depressed over the next 12-18 months and that its currently still adequate liquidity profile could deteriorate driven by negative free cash flows and the need to refinance outstanding debt. Failure to refinance the notes at least 12 months ahead of maturity would likely result in a downgrade.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe company's outlook could be stabilised if Iceland is able to stabilize earnings in fiscal 2023 compared to fiscal 2022, and gradually improve its Moody's-adjusted interest coverage improving towards 1.5x while generating positive free cash flow.Conversely, further pressure on the company's profits or credit metrics could lead to a downgrade: quantitatively, with Moody's-adjusted interest coverage remaining at 1x or below and negative free cash flow generation or any deterioration in the company's liquidity profile would also lead to a downgrade, including failure to refinance the 2025 notes at least 12 months ahead of maturity. LIST OF AFFECTED RATINGS Downgrades: ..Issuer: Iceland Bondco plc ....BACKED Senior Secured Regular Bond/Debenture, Downgraded to B3 from B2..Issuer: Iceland VLNCo Limited....Probability of Default Rating, Downgraded to B3-PD from B2-PD....LT Corporate Family Rating, Downgraded to B3 from B2Outlook Actions:..Issuer: Iceland Bondco plc....Outlook, Changed To Negative From Stable..Issuer: Iceland VLNCo Limited....Outlook, Changed To Negative From StablePRINCIPAL METHODOLOGYThe principal methodology used in these ratings was Retail published in November 2021 and available at https://ratings.moodys.com/api/rmc-documents/356421. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.PROFILEHeadquartered in Deeside, Flintshire, UK, Iceland VLNCo Limited is the parent holding company of the Iceland Foods group. Iceland is a UK retail grocer, which specialises in frozen and chilled foods, alongside groceries. Since its creation in 1970, Iceland Foods has expanded its reach in the UK to become a national operator with total annual revenue of around Â£3.7 billion in fiscal 2022 and 830 core Iceland and 157 The Food Warehouse stores.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating. Roberto Pozzi Senior Vice President Corporate Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London, E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Richard Etheridge Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. 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